SEC Pursues Unregistered Adviser to Private VC Funds

Investment Management Update

Date: February 12, 2020

Key Notes:

  • Advisers to VC funds may be required to register with a state or the SEC.
  • VC fund advisers may be eligible to instead file as exempt reporting advisers with the SEC.
  • Persons who fail to register or properly confirm an available exemption are subject to enforcement actions and penalties.

On January 31, 2020, the Securities and Exchange Commission (SEC) announced that it was bringing administrative proceedings against the principal of an unregistered adviser to multiple private venture capital funds. The SEC commenced its action after the Connecticut Department of Banking issued a final order against the principal for failing to register with the state as an investment adviser and investment adviser representative.

This case demonstrates the common misconception that venture capital fund advisers are immune from regulatory oversight. Understanding the relevant state and federal laws and any registration or filing requirements is paramount for any private fund adviser. The laws governing the investment management industry can be complicated; the fact that a similar group operating in the market has not registered doesn’t mean that approach is acceptable or available to you.

Section 203 of the Investment Advisers Act of 1940, as amended (Advisers Act), prohibits individuals who are not registered from providing investment advisory services. Sections 206(2) and 206(4) of the Advisers Act prohibit advisers from engaging in fraudulent and deceitful transactions or courses of business with clients. All states have laws governing investment advisers.

There are exemptions available to venture capital funds to avoid registration under the Investment Company Act of 1940, and venture capital fund investment advisers may be eligible to file as exempt reporting advisers with the SEC and avoid registration. However, state laws, regulatory assets under management, the types of clients the firm serves and how the fund is structured impact the analysis. Therefore, each venture capital fund investment adviser and general partner to a venture capital fund should review their particular circumstances to determine whether they must register or file as an exempt reporting adviser.

Background

In 2003, Barton Stuck formed Signal Lake SF, LLC, which was the general partner to Signal Lake Side Fund, L.P., Signal Lake Side Fund II, L.P., and Signal Lake Fund IIA, L.P. (collectively, the Funds). The Funds were formed as venture capital funds through which investors could invest in technology companies. Stuck also formed Signal Lake Management, LLC (Signal Lake) to serve as the adviser to the Funds.

Commencing in 2008, Stuck, on behalf of Signal Lake, offered and sold limited partnership interests in each of the Funds to investors throughout the United States. In 2010, he fraudulently induced the sale of additional limited partnership interests by exaggerating the total amount of investments in the Funds. Further, from 2008 to 2014, Signal Lake and Stuck served as an adviser to the Funds and were compensated for providing securities-related advice to the Funds without being registered as an adviser in any state or with the SEC.

Connecticut Final Order

In June 2017, Connecticut issued a cease and desist order against Stuck, Signal Lake and the Funds. After two hearings in 2017, the Connecticut Department of Banking entered a final order for multiple violations of the Connecticut Uniform Securities Act, which concluded that Stuck and Signal Lake transacted business as an unregistered adviser and adviser agent. Stuck also was individually fined $500,000.

SEC Proceedings

After Connecticut issued its final order, the SEC initiated administrative proceedings against Stuck for the violations outlined in the Connecticut order. It has ordered a public hearing to consider the evidence and required Stuck to provide a response to its allegations. In addition to any administrative penalties that might be issued by the SEC, Stuck was charged and pleaded guilty to four criminal charges ranging from wire fraud to money laundering, all stemming from his relationship with the Funds.

Compliance Is Key

Private fund founders and principals should carefully examine the SEC’s registration requirements and those of the state(s) where they have their office(s) or conduct business when planning and structuring and before commencing any private offerings. This case clearly demonstrates the perils of providing unregistered investment advice, which could have been easily avoided by understanding the regulatory landscape, seeking appropriate legal advice and either registering as an adviser or documenting or filing for any appropriate exemptions. An investment adviser that is exempt from state registration must register with the SEC once it has regulatory assets under management of $25 million or more. However, a private fund adviser may instead file with the SEC as an exempt reporting adviser by filing an abbreviated Form ADV. Even a late filing is preferable to ignoring the problem.

FOR MORE INFORMATION

For more information, please contact:

Cassandra W. Borchers
513.352.6632
Cassandra.Borchers@ThompsonHine.com

Brian Doyle-Wenger
614.469.3294
Brian.Doyle-Wenger@ThompsonHine.com

This advisory bulletin may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgment of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.

This document may be considered attorney advertising in some jurisdictions.

© 2020 THOMPSON HINE LLP. ALL RIGHTS RESERVED.